Decentralized Islamic finance: blockchain as a cure for the murabaha syndrome

At the core of Islamic finance ideal models, profit and loss sharing (PLS) contracts (mudaraba and musharaka) have been avoided in practice by Islamic financial institutions (IFIs) who, since their inception, suffer from a Murabaha Syndrome by relying on debt-like instruments as their main financing tools. While the literature focuses on moral hazard and adverse selection as the main reasons for the underuse of PLS, we show that these asymmetric information issues are not a cause but a consequence of a deeper problem that the existing scholarship has overlooked. The main barrier to using PLS is the difference between the institutional framework that once enabled traders to use mudaraba and musharaka to finance their business ventures and the impersonal exchange framework in which modern IFIs operate. In this chapter, the study assesses the main challenges to the PLS financing application, focusing on mudaraba, and explore the solutions offered by the blockchain and the nascent Decentralized Finance (DeFi) that are relevant to Islamic Finance. We argue that blockchain can offer an institutional solution to the Murabaha Syndrome and help reduce the gap between Islamic finance ideals and practices.